Saturday, January 20, 2007

Saturday Forum: Accounting for the Drought

Australia’s wheat, barley and canola crops are down 60 per cent, our rice crop is down 90 per cent, our total farm production is down 20 per cent and more than half of our agricultural land is in drought.

And yet… it has to be said… the broader Australian economy is healthy.

The droughts of the early 1980’s and the early 1990’s helped push Australia into recession. But not this one. Not after Australia’s eleventh hottest year on record, not with water storage on Snowy at an all-time low, not with the Murray at risk or drying up and not with farm income at its lowest since surveys began.

The city of Canberra feels brown, hot and prosperous. Australia’s other capital cities, all of them on the coast, notice the drought even less...

It is as if what happens on our farms no longer matters to the rest of us. And to a large extent it doesn’t. Our farms are no longer essential to ensure that we are fed. Countries such as Thailand with abundant water can grow rice more easily than can the irrigated rice farms in Australia’s east. New Zealand with plenty of water and naturally green pastures can make milk more cheaply than can Australian irrigated dairy farms.

Most of Australia’s income no longer comes from making food. Only 3 out of every 100 dollars earned in Australia comes from agriculture (before the drought it was 4 out of every 100). The overwhelming bulk of our income now comes from services – things such as retailing, the media, selling property, and banking and insurance. All up, income from providing “services” accounts for 64 out of every 100 dollars earned in Australia.

Even when it comes to exports, services are now more important than is agriculture. Australia earns 23 per cent of its export income from services, 17 per cent from agriculture. With that income, as well as the 40 per cent of export income that we earn from mining, we are able to buy food from wherever we want.

That’s not how it used to be. At the time of the Federation drought at the turn of the last century, Australia earned more from wool than it did from mining, and during the drought that earning stream collapsed. Historian Geoffrey Blainey has written that as recently as the 1930’s primary industries formed the backbone of the Australian economy, providing most our export income and earning more domestically than did manufacturing. Farms not only provided us with food, but also with much of our fuel in the form of hay for horses.

During the current financial year the Bureau of Agricultural and Resource Economics expects farm income to collapse 72 per cent. Australian farms earned $9.3 billion last financial year. They are expected to earn just $2.6 in this one. For many farmers the collapse will be devastating, but for the rest of us, the official forecast suggests we won’t much notice.

The Treasury has wound back its forecast for nationwide economic growth by three quarters of one per cent. It now expects the economy to grow by 2.5 per cent this financial year instead of 3.25 per cent. It expects the drought to directly cut economic growth by 0.5 per cent and indirectly by a further 0.25 per cent.

It is possible that the Treasury is underestimating the broader indirect effect. Lower farm incomes lead to lower spending by farms and lower spending in the towns they surround cutting other incomes. Traditional “multipliers” as they are called suggest that the total impact of the drought could be higher than the ones the Treasury is using, perhaps increasing the total cost of the drought to as much as one per cent of economic activity.

But at the moment there are good reasons to believe that the traditional multipliers would overstate things. Much of Australia is enjoying something close to full-employment. If someone loses a job on a farm or in a firm that services farms that person is quite likely to find a new job somewhere else. When Cyclone Larry destroyed most of Australia’s banana crop in March last year a reported 4,000 Australians found themselves out of work. But not for long. Many moved on to higher paying jobs in the booming Queensland mining industry labour was in short supply. Banana farms are finding it hard to entice them back.

According to Westpac’s rural economist Justin Smirk about 100,000 rural jobs have been lost since the start of the last drought in 2002. But he says it is very hard to find any evidence suggesting that the droughts have cost jobs overall. Total employment in Australia has increased by more than one million since 2002. The implication is that most of the people who have lost jobs in industries related to the rural sector have found new jobs in industries outside it.

This doesn’t mean that everyone who has lost of job as a result of the drought has been able to find another one. Not all of the new jobs have been in the same locations as the old jobs and not all of them have required the same skills. But it does mean that this time the multipliers that have in the past been used to estimate the economy-wide effect of a drought would overstate the damage.

The cost to Australian taxpayers of supporting farmers the Commonwealth’s so-called Exceptional Circumstances program has climbed to $2.3 billion, around $38 million each week. And there is every indication that it could climb higher.

Asked in December how much longer the Government could “keep throwing money at our farmers, since there’s no sign that the drought is going to ease” and at what stage do we pull the pin and say that some farms are no longer viable the Treasurer Peter Costello replied that, “the Australian Government will stand by Australia’s farmers because they are people who work hard, they are people who love the land and they are people who are going through a tough time. And if that takes further drought assistance, we’ll do it.”

The point the questioner was making is that if the drought continues and becomes normal in much of Australia Exceptional Circumstances support will be being given in circumstances that are no longer exceptional.

Professor Peter Cullen of the Wentworth group of concerned scientists believes that as much as 10 per cent of Australia’s farming land is now unfarmable. Continuing to pay subsidies to farmers to farm it is pointless and cruel.

The rules for Exceptional Circumstances payments allow the Commonwealth to bite the bullet. They require grants to be paid only to support farm businesses that are “viable in the long-term”. But the Treasurer’s words suggest that the Government’s definition of what is viable is unlikely to change any time yet.

Most of the Commonwealth support is in the form of large interest rate subsidies. An Exceptional Circumstances declaration entitles viable farmers to a subsidy of up to 50 per cent of their interest payments in the first year and up to 80 per cent in future years up to a maximum of $100,000 a year.

It is payment open to attack on grounds other than whether or not it is going to farms with a future. Since the grant was introduced in 1993 it has been factored in to the financial decision-making of farmers. They are more likely to buy farms and prepared to pay more for them than they would have been without the knowledge that there was an exceptional circumstances interest subsidy. In the same way that the grants available under the Commonwealth’s First Home Owners Scheme pushed up the price of houses, leaving many new home buyers little better off, it is possible that the Exceptional Circumstances subsidy put upward pressure on the price of rural land. If this is the case the subsidy would have helped the farmers who have sold land since 1993 rather than those farmers who have bought since and are facing drought now.

Another scheme may be of more genuine, if less costly, help. Introduced in 1999, the Commonwealth’s Farm Management Deposits Scheme allows farmers a tax deduction for setting aside what would normally be taxable income in their profitable years and parking it in an authorized institution such a bank, building societies and credit union. It can be withdrawn for use at a time when the farmer’s tax rate is lower because times are hard.

Curiously at the moment the authorized institutions are holding $2.5 billion of the farmer’s money, more than ever before, suggesting that not much is being withdrawn. This might be because recent bumper crops and high cattle prices mean that our farmers don’t need the money, or it could be because they won’t need it until the drought ends and it is time to restock.

Two economists at the Australian National University Bruce Chapman and Linda Botterill have suggesting what they believe is something better. They would wipe aside the existing farm support schemes and instead grant loans in times of drought, to be repaid only when farm income rises beyond a certain point.

It is how the government’s Higher Education Contribution Scheme works. Australia supports university students when they need it but gets something back when the students are able to pay.